Brazil, Destined For Boom or Bust: Part Two

(Continued from Part One.)

The carry trade has been a major component of Brazil’s capital flows over the last few years, more than financing the growing current account deficit which reached US$ 47.5 billion in 2010. FDI nearly doubled from US$25.9 billion in 2009 to US$ 48.5 billion in 2010 as investors jumped on the bandwagon, borrowed cheap dollars and invested in high yielding Brazilian assets or even deposits. One of the first steps the new head of Brazil’s central bank, Alexandre Tombini, took on upon entering office was to raise the SELIC, the Banco Central do Brasil’s overnight lending rate, another half point to 11.25 percent, according to a Telegraph article. Borrowing dollars at 1-2 percent and getting a return at 11 percent plus an appreciating currency has been a one-way bet, as the flow of money into the country has exacerbated the problem. The paper observes that inflows have turned the Real into Latin America’s “Swiss franc,” driving it up 39 percent against the dollar and almost as much against China’s semi-fixed Yuan over the past two years.

While the government is most vocal about the depreciation of the US dollar, deliberately driven down, they feel, by quantitative easing, the Brazilian government has not been slow to action against their largest trading partner — China — adopting 28 anti-dumping measures covering steel, tires, synthetic fibers, chemicals, shoes and toys. The most recent, toys, saw import duties rise from 20 to 35 percent this month. But the government cannot wholly blame foreign governments for their problems, particularly the current account deficit. Fiscal policy is ultra loose, the government pump primed the economy last year to win re-election raising state spending by 11 percent, inflation jumped to 5.9 percent in December as the country was awash with money and the domestic economy roared away. Like China, the state development bank lavished subsidized credit on companies to keep the economy humming during the global credit crisis. Unlike China, Brazil has full convertibility, still largely unrestricted capital flows and a floating exchange rate — the results are plain to see. Capital flows may not remain unrestricted for long, however. Brazil is so concerned by developments that they are looking at a range of measures to protect domestic manufacturers and restrict flows of hot money into the country. Expect further import duties to be applied this year and probably cuts in government expenditure in an attempt to take some heat out of the economy. Whether that will be enough to bring down the Real remains to be seen; our expectation is not, but if Brazil is not to suffer a repeat of previous booms and busts, action on a variety of fronts will be required.

–Stuart Burns

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